Indonesia collects too little tax to pay for Prabowo's plans

Indonesia's economy looks sound on paper, but the government has a basic money problem: it collects very little tax. Writing for East Asia Forum, the author explains that state revenue is only about 12 percent of GDP, the total value of everything the country produces in a year. The regional average is closer to 20 percent, so Indonesia's tax take is barely above that of Laos, a much poorer neighbour where income per person is 40 percent lower. With so little coming in, the state struggles to pay for both the roads and factories Prabowo wants and the costly welfare programs he has promised, such as free school meals.

President Prabowo Subianto said he would lift the tax-to-GDP ratio to 16 percent during his first term. So far the record points the other way. On the eve of a planned rise in VAT, the value-added tax added to most goods and services, from 11 to 12 percent, he pulled back and applied the increase only to luxury goods. That kept a campaign promise but left revenue growth weak, just as spending climbs.

The squeeze is now testing a rule that has guarded Indonesia's financial reputation for more than twenty years. The budget deficit, the gap between what the state spends and what it earns, is pushing toward the legal ceiling of 3 percent of GDP, set in 2003. Holding that line has already forced deep cuts and reshuffles across the budget. If spending keeps rising, the government must cut more, borrow more, or risk breaking a limit that markets watch closely.

Why it matters

Weak tax revenue leaves the government less room for schools, roads, and help when prices rise, and more pressure to trim popular programs or take on debt. If the deficit breaks the 3 percent line, investors could lose confidence and push the rupiah down further, which raises the cost of imported food, fuel, and medicine. Watch the budget numbers over the coming months, because that 3 percent line is the signal to follow.